Testimony: Export Compliance: Ensuring Safety, Increasing Efficiency

Testimony of Arthur Shulman

Before the Committee on Foreign Affairs
Subcommittee on Terrorism, Nonproliferation, and Trade
United States House of Representatives

May 20, 2008

I am pleased to appear before this distinguished Subcommittee to discuss the importance of strong export controls in stemming the spread of mass destruction weapons.

I will cover four topics. First, the dangers posed by the administration’s present effort to weaken the export licensing process; second, the need to improve industry’s ability to police itself; third, the difficulties that will be created for verification and enforcement as the government continues to reduce licensing requirements; and fourth, the risks of transshipment and diversion posed by places like Dubai.

A nuclear sub-prime crisis?

For over a decade, we have seen a consistent push by industry to weaken U.S. controls on the export of militarily sensitive technologies. Though tasked with protecting U.S. national security, successive administrations have succumbed to the pressure to “modernize” export controls and to make them less “burdensome” and more “efficient.” The result has been to emphasize greater profits from exports and disregard the risk that American products will be diverted. This policy is very like the one that some of our banks adopted recently when they disregarded risk, thought only of profits, and shoveled money out the door to finance real estate sales. Risks are real, and the penalties for ignoring them are real, as we are now learning in the financial arena. The same is true for national security. If our government continues to diminish export controls, we will pay the penalty of watching our own products arm our enemies. We will have produced the equivalent of a nuclear sub-prime crisis.

There are a number of ways in which the administration has chosen to reduce controls. I will discuss two of them here today. First, there is the “Validated End-User” (VEU) program initiated last year by the Commerce Department. That program allows select companies to receive controlled dual-use goods without export licenses. Second, there are the defense trade cooperation treaties with the United Kingdom and Australia, now awaiting approval by the Senate. These treaties would create new “communities” of buyers in those two countries who could receive munitions items from the United States license-free.

Making sure the “trusted” are trustworthy

Both the VEU program and the treaties depend on identifying “trusted” customers abroad. Yet, it is far from clear whether the government agencies seeking to rely on such “trusted” buyers are able and willing to screen carefully and to verify sufficiently. In January, my organization published a report on the VEU program. The report revealed that the “trusted” customers being chosen were not necessarily trustworthy.

The Commerce Department’s Bureau of Industry and Security (BIS) claims to select each Validated End-User based on “the entity’s record of exclusive engagement in civil end-use activities,” and on “the entity’s relationships with U.S. and foreign companies,” among other factors. BIS also requires VEU applicants to supply an “overview of any business activity or corporate relationship that the entity has with either government or military organizations.” All of this information is supposed to be vetted by BIS and by an interagency committee, which must approve each candidate unanimously. But our report on the program reveals that two of the first five Chinese companies designated as VEUs are closely linked to China’s military-industrial complex, to Chinese proliferators sanctioned by the United States, and to U.S. companies accused of export violations. Commerce hand-picked these companies, tellingly noting that they accounted for 18% of licensed U.S. exports to China.

Part of the problem is that Commerce’s procedures are not well-defined and appear to be getting weaker. For example, BIS intended to rely on mandatory end-use visits in China to verify that American exports were not being diverted. But the Chinese Ministry of Commerce refused blanket consent to such visits. BIS then settled for reviews if “warranted” and with ample notification to the Chinese government. BIS has also eliminated a requirement that U.S. exporters report annually what they sell under the VEU program. BIS argued that it can already access this information through the Automated Export System (AES), despite questions as to whether the system can track this data in the detail required. Congress should insist that the program be halted until the GAO determines that it does not reduce our national security.

The defense trade cooperation treaties with the United Kingdom and Australia are heading down the same dangerous path. The treaties establish new exemptions from export license requirements for arms trade with each of those countries. But the treaties, as well as their implementing arrangements, leave many important questions unanswered.

The treaties allow license-free arms exports to foreign buyers in “approved communities” and for an as-yet undisclosed list of “operations, programs and projects.” But as with the VEU program, details are unclear about which companies will be deemed “trusted,” and how our government will ensure that they continue to be trustworthy. For example, it is unclear whether the government will screen freight forwarders and other intermediaries involved in arms sales under the treaties. The treaties and their implementing arrangements are also vague about verification, site visits and inspections.

Both the VEU program and the treaty exemptions serve to decrease our government’s role in controlling sensitive exports. This creeping abrogation of a key national security function is highly risky. By eliminating the pre-shipment checks performed by licensing officers, the responsibility for spotting and preventing diversion attempts shifts to the exporter – who may lack the necessary training and resources – and to customs officials, who may lack the ability to screen license-free exports adequately before they leave U.S. ports.

Greater reliance on industry – with little help from government

Although greater reliance is being placed on industry to screen its own transactions, industry has never received enough guidance from the government. An example is the Entity List maintained by BIS. The List is supposed to be a primary means for informing exporters about foreign entities that pose a risk of diversion. An exporter usually must apply to BIS for a license before selling to an entity on the List. The List, however, is incomplete and out of date, especially its China section. For example, an organization listed seven years ago as “13 Institute, China Academy of Launch Vehicle Technology, (CALT), a.k.a. 713 Institute or Beijing Institute of Control Devices” is no longer part of CALT. It is now subordinate to the China Aerospace Times Electronics Corporation (CATEC). Another entry is a mystery: “Xiangdong Machinery Factory.” There are several entities in China with current or former names that can be translated in full or in part as “Xiangdong Machinery Factory,” yet the List supplies no other identifying information about the entity it means to designate.

The Entity List is wholly insufficient to help exporters identify the risky companies and organizations of which they should be wary. Despite criticism from auditors and requests from industry and national security advocates, little has been done to ensure the currency and usefulness of information now on the List.

For several years, the Wisconsin Project has tried through various channels to convince BIS that the Entity List must be updated and made more useful. This spring, we grew tired of waiting and decided to do the work ourselves. In April, we posted on our website (at www.wisconsinproject.org) an annotated version of the Entity List’s China section, complete with updated entity names (including in Chinese) and contact information. We invite exporters to use this new resource for more effective export screening. We also hope that BIS will incorporate our updates in the official Entity List, and make additional requested changes. Then the Entity List can become a real tool for exporters to screen their exports and prevent diversions.

Revising the Automated Export System: H.R. 5828

The automated export compliance screening proposed for the Automated Export System (AES) by H.R. 5828 also has great potential for helping exporters. It would make classification decisions for exporters, and would screen their transactions against the restricted party lists. Such services are now available commercially, but are not affordable for some exporters.

Although H.R. 5828 contains sound ideas, it does not go far enough to make AES what it must become in light of the current trend toward reduced licensing. The following changes would improve the bill:

AES should provide comprehensive coverage of export information. The bill, however, allows the Secretary of Commerce to grant exceptions to mandatory a priori filing. To keep such exceptions to a minimum, they should require interagency approval.

AES must be kept abreast of export control laws and regulations, and it must gather complete information for blocking, tracking and enforcement purposes. AES was not ready to perform a key function for the VEU program (identifying the exported item fully) at the time of VEU implementation; this should not happen.

Sharing of AES data with other appropriate federal agencies should be mandatory, and procedures for such sharing should be transparent. For example, members of the interagency committee charged with selecting Validated End-Users should be able to track VEU exports independently to verify that each “trusted” customer remains trustworthy. Federal investigators and prosecutors should have ready independent access to export data.

In the proposed scheme to license AES filers, procedures for revocation or suspension of licenses should include an option to suspend a license immediately (blocking access to the system) if a violation of export control or AES rules is imminent. An analogy is the Temporary Denial Order available under the Export Administration Regulations.

The automated export control screening/blocking mechanism for AES could reduce inadvertent errors by filers and help less experienced exporters. By retaining filing data, the system could also decrease diversion risk by limiting bad actors’ ability to “game” the system without being discovered.

Automated screening should be comprehensive across the AES system. It should encompass all export control regulations relevant to AES (including those of the Nuclear Regulatory Commission) and should screen against all restricted party lists (including administrative debarments under ITAR part 128).

The bill does not explain how the automated screening model would apply to the exporters who use post-shipment filing. If post-shipment filing is to continue, its “trusted” users must be vetted even more thoroughly.

The system should be more consistent in screening transactions. The bill describes export compliance conditions which should generate a “fatal error” for an AES filing attempt, and other conditions which merit only “warning” messages. But some of the conditions resulting in warnings do not appear to be qualitatively different from those producing “fatal errors.”

The bill should explicitly mandate the recording and retention of AES users’ actions while filing export data, and should allow for use of such data for enforcement. This would allow detection of attempts to circumvent controls by changing information initially rejected by the screening system.

Verification and enforcement are more difficult without export licenses

The GAO has noted concerns from the Justice Department and from Customs about investigating and prosecuting violations when exemptions from licensing requirements apply. The GAO found that “it is particularly difficult to obtain evidence of criminal intent since the government does not have license applications and related documents that can be used as proof that the violation was committed intentionally.” In addition, the Justice Department itself has pointed to the importance of the “domestic evidentiary trail” created by the licensing process, and warned that licensing exemptions for countries (like those created by the munitions treaties) could “greatly impede the ability of the law enforcement community to detect, prevent and prosecute criminal violations.” In the absence of export licenses, it appears that the Automated Export System will be the only record the U.S. government has of exports under “trusted” customer programs. Further, the House International Relations Committee has noted the inclination of the courts to “view the licensing requirement as highly relevant to the establishment of a person’s legal duty under U.S. law” and the tendency of federal prosecutors to “regard the absence of a license requirement as signifying an activity of lesser importance to the U.S. government…”

As fewer exports of sensitive goods are screened by licensing officials, export control must also rely more on Customs to review outgoing shipments and verify the self-policing activities of industry. But there is evidence that Customs may not be up to the task. Customs and Border Protection (CBP) of the Department of Homeland Security (DHS) is charged with inspecting outbound shipments. But in September 2007, the DHS Inspector General reported that “outbound shipments are not consistently targeted and inspected by CBP Officers at the ports for compliance with federal export laws and regulations … because CBP does not devote sufficient resources to the function [and] does not have the information necessary to effectively monitor the program.” Immigration and Customs Enforcement (ICE), also at DHS, is responsible for investigating export violations. But ICE is also responsible for immigration enforcement. The rapidly growing demands of this competing function may well diminish the resources available for export control.

Oversight remains necessary

Until last year, the Inspectors General of the Departments of Commerce, Defense, Energy, and State, in consultation with the Director of Central Intelligence and the Director of the Federal Bureau of Investigation, were required by statute to assess whether export controls and counterintelligence measures are adequate for preventing the acquisition of sensitive U.S. technology and technical information by countries and entities of concern. The Inspector General at the Department of Homeland Security also participated in these reviews. The Inspectors General identified numerous shortcomings, prompting improvements. These reviews should be re-instituted and made permanent.

Transshipment and Diversion – the case of the United Arab Emirates

The subcommittee has asked me to discuss the risks of transshipment and diversion. I would like to offer for inclusion in the record an article listing transshipments of dangerous items through Dubai in the United Arab Emirates. The article appeared in the New York Times on March 4, 2004. Unfortunately, things have not improved much since then.

My organization has documented how Dubai and other points in the United Arab Emirates have served for decades as the main hubs in the world for nuclear and other smuggling. In the 1980’s, several shipments of heavy water, a nuclear reactor component, were smuggled from China, Norway and the Soviet Union through Dubai to India, so India could use its reactors to create plutonium for nuclear weapons. In the 1990’s, companies in Dubai willingly coordinated the notorious smuggling network of Pakistani scientist A. Q. Khan. Through Dubai to Iran were shipped two containers of gas centrifuge parts from Mr. Khan’s laboratories for about three million dollars worth of U.A.E. currency. Also in the 1990’s, a Dubai company attempted to violate U.S. export control laws by shipping Iran a material useful for manufacturing ingredients for nerve gas, and the German government listed six firms in Dubai as front companies for Iranian efforts to import arms and nuclear technology. In October 2003, Emirates customs officials, over U.S. protests, allowed 66 high-speed electrical switches ideal for detonating nuclear weapons to be sent to a Pakistani businessman with ties to the Pakistani military. An affidavit, signed by an official in the U.S. Department of Commerce, shows that the director of customs in the Emirates refused to detain the shipment despite a specific request by one of the Department’s agents.

Even more recently, American-made computer circuits received by Mayrow General Trading in Dubai were diverted to Iran, and eventually turned up in unexploded roadside bombs in Iraq. Other dual-use goods – including specialized metals, aircraft parts and gas detectors – have also continued to move through Dubai to Iran, Syria and Pakistan. Until the Mayrow discovery, the U.S. government had quietly pressed Emirates officials (with little success) to monitor U.S.-origin dual-use goods in the UAE, and to do more to prevent their diversion. After Mayrow, the administration issued what was widely viewed as a public threat to the Emirates. The Commerce Department proposed in February 2007 to designate “Destinations of Diversion Concern,” and to impose additional restrictions on exports to such places.

But the proposal stalled after UAE officials promised to adopt an export control law. The law was adopted last year, and Emirates officials point to a handful of enforcement actions since then. Nevertheless, export control experts and even Dubai traders red-flagged by the United States say that little has actually changed. Dubai is still a grave security risk. Iran continues to import large quantities of goods through Dubai’s revolving door. It will not be possible to curb Iran’s nuclear imports unless Dubai and the other Emirates clean up their act.

My organization supported the “Destinations of Diversion Concern” proposal when it was issued, and recommended that the United Arab Emirates be so designated immediately. I recommend now that Congress take this step through legislation. Such a designation would send a strong public signal that there are consequences for choosing profit over international security. The UAE should be treated the same way for export control purposes as countries like Pakistan that are using it as a diversion point.